Smaller Boards Get Bigger Returns

Companies With Fewer Directors Tend to Outperform Their Peers, New Study Shows

Smaller boards are a better deal for investors, according to an analysis for The Wall Street Journal by governance researchers GMI Ratings. WSJ's management reporter Joann Lublin discusses on the News Hub with Sara Murray.

Companies with fewer board members reap considerably greater rewards for their investors, according to a new study by governance researchers GMI Ratings prepared for The Wall Street Journal. Small boards at major corporations foster deeper debates and more nimble decision-making, directors, recruiters and researchers said.

Take Apple Inc. In the spring when BlackRock founding partner Sue Wagner was up for a seat on the board of the technology giant, she met nearly every director within just a few weeks. Such screening processes typically take months.

But Apple directors move fast because there only are eight of them. After her speedy vetting, Ms. Wagner joined Apple's board in July. She couldn't be reached for comment.

Among companies with a market capitalization of at least $10 billion, typically those with the smallest boards produced substantially better shareholder returns over a three-year period between the spring of 2011 and 2014 when compared with companies with the biggest boards, the GMI analysis of nearly 400 companies showed.

Companies with small boards outperformed their peers by 8.5 percentage points, while those with large boards underperformed peers by 10.85 percentage points. The smallest board averaged 9.5 members, compared with 14 for the biggest. The average size was 11.2 directors for all companies studied, GMI said.

"There's more effective oversight of management with a smaller board," said Jay Millen, head of the board and CEO practice for recruiters DHR International. "There's no room for dead wood."

Many companies are thinning their board ranks to improve effectiveness, Mr. Millen said. He recently helped a consumer-products business shrink its 10-person board to seven, while bringing on more directors with emerging-markets expertise.

Small boards are more likely to dismiss CEOs for poor performance—a threat that declines significantly as boards grow in numbers, said David Yermack, a finance professor at New York University's business school who has studied the issue.

It's tough to pinpoint precisely why board size affects corporate performance, but smaller boards at large-cap companies like Apple and Netflix Inc. appear to be decisive, cohesive and hands-on. Such boards typically have informal meetings and few committees.

Apple directors, known for their loyalty to founder Steve Jobs, have forged close ties with CEO Tim Cook, according to a person familiar with the company. Mr. Cook frequently confers with individual directors between board meetings "to weigh the pros and cons of an issue," an outreach effort that occurs quickly thanks to the board's slim size, this person said.

Mr. Cook took this approach while mulling whether to recruit Angela Ahrendts, then CEO of luxury-goods company Burberry Group PLC, for Apple's long vacant position of retail chief. Private chats with board members helped him "test the thought" of recruiting her, the person said. She started in April.

Ms. Wagner, Apple's newest director, replaced a retiring one. The board wants no more than 10 members to keep its flexibility intact, according to the person familiar with the company, adding that even "eye contact and candor change" with more than 10 directors.

Apple returns outperformed technology sector peers by about 37 cumulative percentage points during the three years tracked by GMI. An Apple spokeswoman declined to comment.

Netflix, with seven directors, demonstrated equally strong returns, outperforming sector peers by about 32 percentage points. Board members of the big video-streaming service debate extensively before approving important management moves, said Jay Hoag, its lead independent director.

"We get in-depth," he said. "That's easier with a small group."

Netflix directors spent about nine months discussing a proposed price increase, with some pushing back hard on executives about the need for an increase, Mr. Hoag said. Netflix increased prices this spring for new U.S. customers of the company's streaming video plan, its first price bump since 2011.

A board twice as big wouldn't have time for "diving deeper into the business on things that matter," Mr. Hoag said.

Theodore "Tim" Solso, chairman of General Motors Co., agrees. In 2012, he became the fourteenth board member at the auto manufacturer. Having 14 directors makes it tough to manage board meetings.

"Often, you have people saying the same thing," he said. "It's just not as efficient as a smaller board."

At Eli Lilly & Co., a major pharmaceuticals maker with 14 directors, the board "is too big to encourage the kinds of discussions you want" because drilling down on different issues simply takes too long, someone familiar with Eli Lilly said. "A number of people feel constrained asking a second or third question."

A big board of a large-cap company can offer certain benefits. In heavily regulated industries, such as financial services, larger boards make more sense, according to a person familiar with Bank of America Corp. "They allow you to engineer more diverse thinking."

Bank of America, which has 15 directors, trailed financial sector peers by about 45 percentage points, GMI said. Spokesman Jerome Dubrowski said the bank disagreed with the study.

Bank of America directors have devised ways to minimize potential drawbacks of their sizable board, according to informed individuals. The five board committees—each with five directors—"do a ton of work" and the full board rarely challenges committee reports, one such person said.

Downsizing a big board can take years. GM's Mr. Solso said the automaker's current 12-member board would benefit from further shrinkage.

"If you get the right 10 people, really great things can happen," he said. Five GM directors are at least 67 years old, the company's latest financial filings show. But only one member reaches the mandatory retirement age of 72 during 2015. "Through natural attrition, we may not replace all the directors," Mr. Solso said.

This doesn't surprise me at all. To craft a small board requires more discipline than a larger board. I get nervous when it is too small in case someone needs to leave.

I commented a few years ago on Steve Jobs board. I felt it was as well designed and efficient as his products. It was small, efficient and each part was high quality. When a high quality board member left for whatever reason, it seemed like Jobs took his time to find a new one that was of similar caliber.

A major reason for Boards that are too big are the various time-wasting (for the most part) requirements under Sarbanes Oxley and other regulatory mandates or so-called best practices that encourage/require a variety of Board committees to review various aspects of a corporation's operations (e.g., compensation, audit procedures, various compliance issues, etc.) Although these standards and procedures may have been adopted for what appear to be good reasons by legislatures and various other players who impact corporate management structure, the resulting delays, decision choke points and other downsides usually have a net negative impact on the performance of the business and, in particular on its decision making processes. The winners: management consultants, auditors and lawyers.

I don't think this is a well done study. They don't seem to have adequately controlled for company size / complexity. Large, mature, and complex companies will have bigger boards on average (e.g. GM)... whereas emerging firms (Netflix, Tesla, various Biotechs) had really good performance in 2011-2013, but smaller boards by their very nature.

The 2011-2013 time frame was very short and was characterized by strong momentum in faster growing, emerging companies in a variety of sectors.

Lengthen the study period to say... 20 years and adequately control for size (instead of using market cap, use a combination of employee count, revenues, or operating profit).

Fewer board members, easier to reach consensus. That makes sense. I hope this will be a trend.

However, fewer members also make diversity more difficult. It is also easier to make decisions if he directors are clones... but the decisions could be catastrophically wrong. Smaller boards mean even more emphasis must be placed on recruiting women, minorities, those with international experience, diverse skill sets, etc.

It might be better for the shareholders to have smaller boards but the CEO generally benefits in perks and bonuses, from the dysfunction of a larger board. Expect this trend of board downsizing not to carry too far. Same for the government.

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